Russia-Ukraine crisis threatens recovery in EBRD region

By Anthony Williams

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The crisis in Russia and Ukraine is having a severe impact on the economies of the two countries and is threatening to slow down the recovery in the wider EBRD region – or even bring it to a complete halt.

The EBRD’s latest economic report predicts growth in the transition region of just 1.4 per cent in 2014, a sharp reduction from the rate of 2.7 per cent forecast in January. A modest upturn of 1.9 per cent in 2015 is possible, but is only achievable if the crisis does not escalate.

Under the EBRD’s most likely scenario, Ukraine would return to recession in 2014, with a contraction of 7 per cent and show no growth in 2015. The Russian economy would stagnate in 2014 and show only minimal growth next year.

However, there is an unusually high level of uncertainty surrounding the forecasts with major risks on the downside.

Under a less-benign scenario including the imposition of financial sanctions in particular, Russia would slip into recession, the output contraction in Ukraine would deepen and average growth in the region would grind to a halt in 2014-15.

“At this point, the Russia-Ukraine crisis would start impacting the global economy,” the report says.

On Russia specifically, the report says recent events have hit investor confidence, which had already been feeble. Any further deterioration in confidence could increase capital flight and lead to even lower investment and slower growth.

High inflation and pressure on the rouble could limit the scope for monetary easing while any fiscal response would be constrained by current oil price levels and supply-side bottlenecks.

Ukraine’s economy is expected to undergo a major, though gradual, adjustment with significant short-term output costs. The country’s IMF programme is expected to help bring down external and fiscal imbalances, complemented by support from donors and international financial institutions, including the EBRD.

According to the economists’ baseline scenario, necessary structural reforms in Ukraine would be implemented on schedule and a systemic banking crisis would be averted. However the costs linked to the recapitalisation of Ukraine’s banks could turn out to be significant.

The political tensions have already dashed hopes that a continuous decline in the growth rate in the EBRD region since 2011 would be reversed this year.

They are also outweighing the positive impact of continued recovery in the eurozone and of a reduction of pressures from the unwinding of easy monetary policy in the United States.

The EBRD report says negative spillovers from the political tensions have so far been largely contained to the neighbourhood of Russia and Ukraine, although several central and south-eastern European economies will be affected.

It points specifically to the three Baltic states as having significant trade and investment links to Russia and Ukraine and predicts a possible deepening of contagion from the crisis in those countries. This will make a dent in the generally good growth outlook for the Central Europe and Baltic states region.

Elsewhere, the EBRD’s economists expect the Slovenian economy to finally emerge from recession. However, it will still probably stagnate this year as necessary corporate restructuring continues. They stress the critical importance of persevering with the necessary reforms that have been under way during the past year.

The Croatian economy is expected to continue contracting because of insufficient reforms.

In south-eastern Europe, Serbia’s economic ties to Russia could add to pressures on growth that will already be affected in the short term from expected government spending cuts. The Russian slow-down could also hit tourism in Bulgaria and Montenegro.

Equally, a Russian downturn is likely to constrain growth in Central Asia although the region on average will see good growth driven by major natural resources projects, as well as in Moldova and Belarus and some countries in the Caucasus.

The Turkish economy performed somewhat better than expected in 2013.

Since the beginning of the year the risk premium facing Turkey has increased, in part reflecting high political uncertainty, and the higher cost of finance is expected to weigh on domestic demand and growth.

In addition, export demand and tourism income may be somewhat constrained by the events in Ukraine.

As a result, growth in 2014 is now expected at 2.5 per cent, down from a January forecast of 3.3 per cent.

The four countries in the southern and eastern Mediterranean (SEMED) where the EBRD invests are less likely to be affected by the Russia-Ukraine crisis, although any reduction in grain and wheat exports from Ukraine could push up costs for Egypt, a major importer.

The EBRD report said growth in the SEMED region was still being affected by both external and domestic pressures, such as stalled reforms and volatile security conditions in Egypt and the impact of regional tensions on Jordan. However, it noted significant political progress in Tunisia which was supporting the economic outlook.

The economic report said recovery in the eurozone was gaining momentum, which was a positive factor for those countries which have the closest links to it – primarily central and south-eastern Europe.

Private capital flows to the transition region as a whole had remained relatively low and a continuation of cross-border deleveraging was delaying the resumption of credit growth.

Read the full Regional Economic Prospects - May 2014 (944KB - PDF)

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